The impact of government bond yield increases on banks

Government bond yields have recently increased in many OECD countries from rock-bottom levels and a further increase is likely with the normalisation of monetary policies. A rise in government bond yields can have a negative effect on commercial bank balance sheets, though the full impact is a prioriambiguous, depending on the size, structure and maturity of total bank balance sheets and the extent of hedging in a specific macroeconomic scenario. The focus here is on a limited and illustrative analysis by looking only at the direct impact on banks’ capital via realised losses when bonds are sold or unrealised losses, when bonds are marked to market.

Unrealised losses of banks due to a rise in government bond yields will increase with the amount of bonds held in the trading book and their maturity. To illustrate the potential scope for such losses, stylised calculations for aggregated banking systems in selected OECD countries have been made. They use data on total banking sector holdings of domestic general government securities, which vary significantly across the analysed countries (see figure below). It is assumed that all these bonds are in the trading book – and therefore marked to market – and that the maturity structure is the same as that of outstanding central government debt, and that bond yields increase by 1 percentage point across the yield curve.

The results suggest that, for most of the countries covered, the capital losses due to a 1-percentage point parallel upward shift of the yield curve are small (see figure above). Japan appears a notable exception, with Japanese banks incurring losses corresponding to 70% of Tier 1 capital, but this is likely to be an overestimation given the simplifying assumptions. For example, the Bank of Japan (2013) estimates – based on disaggregated data – that with the same shock, Japanese banks would incur unrealised losses of 6 trillion yen, i.e. only one-fifth of the above estimate. Even with a parallel upward shift of the yield curve by 3 percentage points, unrealised losses would be 15.3 trillion yen, i.e. around 35% of Tier I capital of large and regional banks. This may be partly due to the fact that the average maturity of bonds held by large and regional banks in Japan are around 2.5 and 4 years, respectively, while the average maturity of the Japanese central government’s outstanding ordinary bonds is 7.3 years, and that not all bond holdings are marked to market.[1]

[1]. Assuming the average maturity of bonds to be 4 years, unrealised losses in the stylised calculations would almost halve.